Financial Planning for the Self Employed
Ameriprise Financial Services

Given today’s economic landscape, job security is not what it used to be. Fewer firms are offering pension plans, many are cutting back on medical benefits and others are outsourcing at least a percentage of their work. As a result, more people are leaving their corporate jobs and steady paychecks to venture out on their own, either by choice or as a result of downsizing. In fact, in the past year, the number of self-employed rose nearly eight percent. There are now nearly 12.2 million people who consider themselves self-employed, according to a December 2003 report from the Bureau of Labor Statistics. Furthermore, according to the same report, from 1979 to 2003, the rate of self-employed among women and other minorities grew even more -- 33 percent for women, 37 percent among African Americans and 15 percent among Latinos.

While working for yourself affords some new freedoms, it also presents unique financial challenges. Whether you are currently among these 12.2 million independent contractors or are considering joining the self-employed work force, here are some important items or factors to consider:

Managing Cash Flow – Whether you are an entrepreneur, freelance writer, plumber or graphic designer, without scheduled paychecks from an employer, you could be facing periods of uneven cash flow. In order to ensure you always have cash on hand, develop a budget and a financial plan that allows for swings in your income. Determine an average of how much revenue you can count on each month and use that as a base for monthly expenses. During months that you earn more, stash that extra cash in an interest-earning savings account or money market account. You can draw from these accounts during months in which you have little to no income. Also, you should consider paying yourself a set salary and keeping your personal and business cash in separate accounts. Combining them can complicate tax deductions and potential reimbursements.

Beware of Credit Card Debt – Along with managing cash flow comes the burden of managing credit card debt. For many self-employed, credit cards come in handy for getting started and with purchasing necessities. However, make sure to utilize your cards wisely either by carrying interest free charge cards and paying the balance in full each month, or by having low interest credit cards, making timely payments and paying more than the minimum each month.

Managing Taxes - Unlike employee paychecks, taxes aren't taken out of income received by independent contractors. You're responsible for paying your own income and Social Security taxes. As a result, it's important that you save for taxes from each payment you receive, before you start spending the income. Otherwise, you may not have the money on hand to pay any taxes due when it's time to file your quarterly estimated or annual return. The good news is that the self-employed may be eligible for certain tax breaks. Contributions to retirement plans, health insurance premiums, auto expenses and travel costs, meals and entertainment, and office-related expenses may all be deductible. Make sure to keep all of your receipts so you can save during tax time.

Don’t Forget Insurance – If you are self-employed, you must also make plans to provide your own health, disability and life insurance. Unfortunately, several studies show that many self-employed are foregoing insurance. For example, according to the latest data from 2004 from the Kaiser Family Foundation, 20 percent of self-employed people did not have health insurance in 2003. Remember that without adequate protection planning including health, disability and life insurance, you can put the financial stability of your business and family at risk. Here are some quick tips to help you calculate the insurance coverage you need.

Health: If you can't get health insurance through a working spouse, consider the new medical health savings account (HSA). An HSA allows you to take a tax deduction for the money you put into the account to pay for out-of-pocket medical expenses associated with a high deductible health care policy. If you don't spend all the money you put into the account, it can remain in the account and earn interest tax-deferred.

Disability: Finding a good, affordable disability policy to replace lost income can be tough for the self-employed, as disability insurers generally work with groups. Consider joining an industry trade association or alumni organization that offers access to disability insurance.

Life: Life insurance can help provide money to pay off your mortgage or send your kids to college should you die. There are many types of life insurance, ranging from term insurance (death benefit only) to cash value (cash accumulation and death benefit) or a combination of the two.

Think About Tomorrow and Long Term– When you are self-employed you must remember to have a long-term vision and continue to save money for your retirement. Luckily, there are many options available to the self-employed such as SEP-IRAs and SIMPLE-IRAs, both of which offer higher contribution limits then traditional IRAs. However, while retirement is certainly an important goal, you should also remember to save at least four to six months’ worth of expenses in an emergency reserve. Your cash reserves will also help you keep credit card purchases down, since you will be able to withdraw cash to pay for unexpected expenses such as car repairs rather then charging these fees on your cards. Finally, in addition to your retirement and emergency savings, be sure to save separately to reach short-term goals, such as new computer equipment or a security deposit for office space, should your business grow.

Get Help - Working on your own can be both exciting and overwhelming, with many new challenges to face. Meeting with a qualified financial advisor can help you prepare a comprehensive financial plan so you can best manage your newly found financial freedom and stay on track during your pursuit of independent success.

This information is provided for informational purposes only. The information is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or your financial advisor. Neither Ameriprise Financial nor its advisors or representatives provide tax or legal advice. The views expressed may not be suitable for every situation.

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